Extended warranties are also called “service contracts” and are warranties that protect a purchase for in addition to the manufacturer’s standard warranty. Extended warranties are big business. According to Warranty Week, consumers spend about $40 Billion each year on extended warranties: $17 Billion for car warranties and $23 Billion for appliances and consumer electronics. Ten companies control 57% of this huge market and their names all start with the letter “A” (Asurion, AmTrust, AIG, Apple, Assurant, Allstate, Ally, Apco, American Home Shield and Amazon).
This is a highly profitable industry as the purchased items rarely require repairs during the warranty period and the repairs rarely cost more than the premium paid to purchase the extended coverage. With rare exception, you should not buy an extended warranty according to Consumer Reports. Some of the key reasons not to buy extended warranties according to CR:
- Many repairs are covered under standard manufacturer warranties
- Repairs are a lot less costly than consumers think. According to CR, the average repair cost of items covered by extended warranties was a mere $26 more than the extended warranty coverage (and the item probably won’t break). Another example reported by the Washington Post is that the average three-year extended warranty for a dishwasher is $157.97 and the average cost of repair for a dishwasher is $159.
- Your credit card may have you covered.
- Issues with the fine print/coverages of extended warranties mean that some repairs you would expect to be covered are not.
None of the above is probably a surprise. We all know that extended warranties aren’t worth it, yet we buy them anyway. Why?
In this research paper, psychologists concluded that the decision to buy a warranty had a great deal to do with a shopper’s mood. If a customer is about to buy something fun (ie, a plasma television rather than a vacuum cleaner), he/she will be more inclined to spend money buying a warranty. This is because consumers value “hedonic” items over utilitarian ones, regardless of the actual price tag. This is especially true if the item is on sale, as finding an unexpected bargain leaves buyers feeling pleased. The study also found that poorer consumers are more likely to buy “potentially unnecessary and overpriced insurance” because they are more worried about the expense of replacing a product if it breaks. Notably, consumers in the study tended to justify purchasing the warranties because they provided them “peace of mind.”
Rationally, instead of a buyer’s mood, the popularity of warranties should logically depend on the likelihood of a product’s failure. Of course, part of the reason why people buy warranties is loss aversion as experimental evidence indicates that people behave as if the value of losses are far greater than the likely market/replacement/repair cost. IFOD on Loss Aversion. They get the extended warranties because the warranty’s price is less in psychological terms than the imagined cost to repair/replace the item. Thus, the emotional tranquility that comes with buying a warranty is not in itself without value – as noted by the “peace of mind” comment above.
I know on most warranties sold less than 15% of cost paid actually goes to cover repairs. The other approx. 85% goes to commissions, marketing, profit, e.t.c. They also are very specific as to what a repair is considered limiting their liability greatly. That should be an indicator as to their necessity.
I also feel like most people buy items they cannot actually afford. For example a car. They can afford the payment but have no money left over to pay maintenance, repairs, e.t.c. month to month. So they buy a $1800 warranty because it’s financed in with the payment. To cover a potential repair that they likely will not have and the warranty likely does not cover. They are better off buying something cheaper and putting the $1800 in the bank to self insure as Michael said. It applies to lesser items as well vehicles being an easy common example.
My 2 cents
non-quantitative factors driving decision making and feeling. sounds like “utility” to me.
I have a different rationale for not buying extended warranties, even if the price was reasonable. The theory of insurance is that a number of similar risks are grouped together since only a portion of the risks will happen in any time period. I own a lot of similar risks: a phone, a tv, speakers, etc. Rather than thinking I have to insure each item separately, I think of it as a pool and self insure. Yes, I may have to fix the tv this year…. but I didn’t have to fix the refrigerator, so the savings from the “refrigerator insurance” is available to pay for other repairs.
So, this is business at its cynical worst. Extended warranties could be priced so they would be a reasonable buy for the consumer, and profitable for the business selling it. The problem for the business is, the incremental sales from a more reasonable price doesn’t offset the profit made selling it at a rip-off price. So, businesses make the rational rather than ethical decision, and put their people in the position of selling something that doesn’t serve their customers well. Hard to preach customer first to your employees in that environment.